Can I get an interest-only period or re-amortize my business loan to lower payments?

Three tools, three different trades

This page is about relief on a loan you already have. Interest-only periods negotiated when a loan is first made, typically on an acquisition or a construction project, are a different conversation; see interest-only periods and amortization. Here the lender is being asked to change a loan that is performing, or about to stop performing, and it will want to know why.

The words overlap in practice. A lender may call a deferral a forbearance, and a forbearance agreement often contains an interest-only period. What matters is what the amendment actually does to the payment schedule, the maturity date and the balance. The distinction between the length of the schedule and the date the loan is due is covered in loan term vs amortization period.

The same loan, relieved four ways

Take a loan with a balance of 1,000, five years left to run, and interest that works out to about 80 a year on the full balance. Left alone, it costs about 243 a year. Here is what each form of relief does to it, before any fee or rate change the lender asks for in return.

Read the table in two directions. Across the rows, the lowest payment today does not come with the lowest payment tomorrow: the interest-only option gives the most breathing room for a year and then asks for the largest regular payment of any option. Down the last column, the cheapest relief in total cost is the shortest one, and the most expensive is the one that lowers the payment for good.

The fourth row is the one owners should watch for. A lender will often agree to a longer amortization but keep the original maturity, which lowers the payment and leaves a large balance due on the old date. That is a smaller payment now in exchange for a refinancing problem later; see refinancing ahead of a balloon maturity.

The test that decides whether relief is worth taking

Relief is worth taking only if the business can pay in full once it ends. That sounds obvious, and it is where most modification requests go wrong, because the payment that follows relief is often higher than the one that caused the trouble.

Suppose the business in the example earned 300 before debt service, covering its payment of 243 comfortably, and then a lost customer cut earnings to 200. Conventional bank lenders commonly look for debt service coverage of at least 1.25x. Test each option against that:

• Interest-only. A payment of 80 is easy to cover at 200. But in month thirteen the payment becomes 293, and covering that at 1.25x takes earnings of about 366, more than the business earned before the customer left. The option works only if the business is expected to grow past where it was.
• Re-amortization. A payment of 170 at 1.25x needs earnings of about 212. A modest recovery gets there, and nothing steps up later, unless the maturity was kept and a balloon waits at the end.
• Deferral. Six months without payments, then 276, which needs about 345. Like the interest-only option, it bets on the business earning more within six months than it did before the dip.

So the right tool depends on the shape of the recovery. A one-season dip with a clear rebound suits an interest-only period or a deferral. A business that is now smaller for good needs a payment that fits its new earnings, which means re-amortization, a refinance or a restructuring. And if no tool produces a payment the forecast can cover, relief only moves the default to a later date, usually with less room to deal with it.

If the forecast cannot cover the payment that follows the relief, the relief is postponing a default, not preventing one.

A lender will want to see that forecast: cash flow month by month through the relief period and for at least a year beyond it, with the month the payment steps up clearly marked, and assumptions tied to evidence such as signed contracts, backlog or cost cuts already made.

What the lender will want in exchange

A modification changes the lender's risk, and it will ask to be compensated or protected. The usual requests, some or all of which appear in most modifications:

• Current financial statements, a year-to-date P&L, the forecast above and a written explanation of what went wrong and what has changed.
• A modification fee and the lender's legal costs.
• A higher interest rate, or a reset of pricing that had stepped down.
• More collateral, often a blanket lien where there was a specific one, or a lien on the owner's real estate.
• Additional guarantors, or confirmation that existing personal guarantees cover the modified loan.
• Monthly reporting, new or tighter covenants, and sometimes an excess cash flow sweep that pays down principal from any upside.
• Limits on owner distributions and compensation during the relief period.
• A partial paydown, or new equity from the owners, at the start.
• In a formal forbearance, an acknowledgment of the debt and a release of claims against the lender.

Timing changes the price. Asked for before a missed payment, relief is a modification of a performing loan. Asked for after, it is a workout, and the lender's leverage is higher. A modification for a borrower in difficulty can also change how the bank grades the loan internally, and a downgraded loan may move to its special assets group, where the terms of every later request get harder.

SBA loans, lines and advances

Not every obligation can be relieved the same way.

• SBA 7(a) loans can be modified, but the lender works within SBA's servicing rules: some changes it can make on its own, others need SBA's consent, and the guaranty depends on following them. Most 7(a) loans were written near the program's maturity limits to begin with, up to 10 years for working capital and goodwill and up to 25 years for real estate, so there is usually less room to stretch the schedule than on a five-year bank loan, and a longer one is the lender's and SBA's decision, not the borrower's.
• Equipment loans are tied to an asset that wears out. Lenders resist amortizing beyond the equipment's useful life, because the collateral would be worth less than the balance. See refinancing equipment loans.
• Lines of credit are relieved by a term-out: the drawn balance is converted into an amortizing term loan. That lowers what is due at renewal but ends the line as a source of working capital. See when a bank won't renew a line.
• Merchant cash advances are not loans and have no amortization to stretch. The nearest equivalent is a reconciliation, which adjusts the debit to actual receipts.

When to refinance instead

Sometimes the current lender's relief is the wrong answer. It may offer only a short interest-only period when the business needs a permanently lower payment, or ask for so much collateral and control that the owner loses room to operate. Sometimes the original structure is the problem: a five-year schedule on assets that last fifteen, or a short-term loan used for long-term needs.

A refinance with a lender whose structure fits can solve what a modification only postpones. An SBA 7(a) refinance requires the new payment to be at least 10% lower than the old and the debt to have been current for the last 12 months, which is exactly the situation of a well-run business on too short a schedule. Private credit lends further on cash flow when banks will not. Whether moving is worth the cost is a calculation; see the refinance break-even and, after a bad year, refinancing after a down year.